Vice presidential candidate Paul Ryan has been pushing Social Security privatization for the better part of a decade. What if his plan was actually implemented? An important new paper looks at what happened when Hungary and Poland attempted something similar with their national pension systems. The results were ugly.

It’s been reported that Paul Ryan is no longer pushing Social Security privatization. House Republican leaders “refused” to let their Budget Committee chair “add changes to Social Security” into the budget he wrote last year and that passed the chamber with solid GOP support. This year, he and his colleagues again “left the program untouched.”

That’s not quite true. Ryan has now written two budgets, both of which include a vague mechanism requiring Congress and the president, in the event that Social Security becomes “not sustainable,” to “put forward their best ideas” for how to correct this. Ryan also lays out a few suggestions for achieving “sustainability”: means testing benefits, and raising the age of eligibility for benefits. Both of these ideas come from the the blueprint for radical restructuring of the U.S. economy produced by Erskine Bowles and Alan Simpson, co-chairs of President Obama’s fiscal commission in 2010.

Ryan served on the Bowles-Simpson commission, and while he didn’t vote for the co-chairs’ proposal, he asserts that his budget “builds upon the Commission’s work.” What else did the Bowles-Simpson report say about Social Security? It called for consideration of private Social Security accounts, which

should encourage Americans to build wealth through savings and investment that will generate a return sufficient to allay fears that retirees will outlive their savings, and should permit Americans to have the option to transmit the remainder of their accumulated savings to their heirs.

Bowles-Simpson doesn’t say whether those private accounts would be carved out of payroll taxes, or created as add-ons to compensate for the loss of benefits their other proposals would impose. The slipperiness of Bowles-Simpson gives Ryan something to hide behind as he heads a powerful House committee and campaigns for the vice presidency.

But what if he had his druthers? We know what Ryan really wants to do with Social Security. He laid it out in a bill he co-authored in 2005. One of the more extreme privatization plans that ever achieved prominent placement in Congress, it would have assigned 4% of wages subject to payroll tax to private accounts – twice as much as similar plans generally proposed.

Ryan said his scheme would pay for itself and require no benefit cuts because the private accounts would spur investment and thus boost federal revenues, which could then be used to pay currently promised benefits – a remarkably pure expression of pie-in-the-sky, supply-side economic optimism. When Social Security’s actuaries, their feet firmly planted on Planet Earth, analyzed it, they found the Ryan plan would require $2.4 trillion of new borrowing over just the first 10 years to make up the revenue lost by diverting it to private accounts.

A cautionary tale
Fortunately, nothing of the sort became law in the U.S. But a new paper by Elaine Fultz, a longtime, highly regarded pension scholar and former director at the International Labour Organization, gives us a taste of what might have been – and still could be. It looks at what happened when two former Soviet-bloc countries partially privatized their national pension plans – and then waited for Ryan’s supply-side miracle to cover the cost. Fultz’s paper, “The Retrenchment of Second-Tier Pensions in Hungary and Poland: A Precautionary Tale,” published in the latest issue of the International Social Security Review and is available here, is must reading for anyone who wants to understand just how ill-conceived and unworkable pension privatization really is – not just for practical but for political reasons.

A little background: Pension privatization became a hot idea in the 1980s, after Chile switched to a private account-based system. That experiment hasn’t turned out as well as advertised either, according to some scholars. But by the mid-1990s, the idea caught on with the World Bank, which was prescribing blueprints for radical free-market “reform” in Latin America and Eastern Europe in exchange for much-needed loans and subsidies. Officials in these countries embraced pension privatization as a quick way to build up a pool of capital that could, they were told, offset government spending cuts and jump-start their economies – and, in so doing, guarantee them a future on the rubber-chicken circuit of multinational think-tanks and lending institutions.

The result was nothing short of scandalous. Countries without the least experience as capitalist economies and practically none of the infrastructure needed to make it work, from Kazakhstan to Bolivia, embraced private pension accounts as an economic panacea. It seemed to work at first, because most of these countries had relatively young populations, and actual pension benefits wouldn’t need to be paid out for years to come – enough time for the perpetrators to accept the applause and move on to new, international careers.

As Fultz tells the tale, Hungary and Poland, which implemented privatization legislation in 1998 and 1999, respectively, both funded new private accounts by diverting funds from their existing national pension systems. But in neither country did the legislation specify how the hole was to be filled. Instead, the two governments borrowed – just as the Social Security actuaries predicted Congress would have to do under the Ryan plan. By 2008, borrowing to shore up pension benefits amounted to some 1.5% of GDP annually in both Poland and Hungary.

There were other problems. When the worker retired, the assets accumulated in her private account were supposed to be used to purchase an annuity that would throw off a stream of income for her to live on. But rules for such conversions were either entirely missing (Poland) or else were full of loopholes (Hungary). Without guaranteed, regular cost-of-living adjustments, workers in both countries were at risk that inflation would erode their private pensions. Female workers were vulnerable to gender discrimination in the calculation of benefits – meaning that women, who on average live longer, would wind up on the short end of the stick.

Another problem was the management fees that private institutions were allowed to charge to manage and administer the private accounts. Just as proved to be the case in Chile, these could be quite large, wiping out a big chunk of the returns workers were supposed to enjoy. As concerns built up among opposition politicians, pension experts, and the press, the Hungarian and Polish governments tried and failed to resolve the indexing and gender treatment problems. Proposals were introduced to rein in fees, but these were watered down due to lobbying by the now-powerful private fund managers.

Matters came to a head after the 2008 financial crisis, when private accounts lost value precipitously, borrowing money to fund traditional pensions became more burdensome, and worker and retiree distress suddenly became more urgent. In 2010, Hungary stopped funding the private-account system, clawed back most workers’ account balances, and used most of the revenues to shore up the public system. Poland, the next year, cut its funding of the private accounts in half. Other countries, including Estonia, Latvia, Lithuania, Romania, and Slovakia, cut back as well.

The Eastern European experiment wasn’t the first to end in disaster. Argentina, which also adopted a private pension system during the privatization boom of the 1990s, announced that the jig was up in 2008. The private accounts had lost most of their value during the country’s financial crash several years earlier. Now, the government announced it would swap some 3 million Argentines out of their accounts, which still held some $30 million of investments.

The governments of both Hungary and Argentina were accused of something heinous: seizing workers’ private assets to shore up their heavily indebted regimes. But the private-account experiments had already proved to be disastrous, and Hungary, for one, had a retiree population in danger of losing their expected benefits.

But the economic downturn had exposed a basic problem in Hungary and Poland, Fultz points out. Workers wanted something reasonable – indexing of benefits, reasonable management fees, and gender-neutral benefits calculations – that private providers weren’t willing to give them. Meanwhile, the diversion of assets from traditional pensions to private accounts undermined the solvency of existing retirees’ benefits. When that problem suddenly grew dire, the deficiencies of the private-account system made it not worth continuing.

It could happen here if Ryan and Mitt Romney – who’s also on the record approving of private accounts – have their way. Whether the accounts are carved out of payroll taxes, as Ryan originally conceived, or added on the side, as the Bowles-Simpson plan appears to advocate, similar issues are likely to overtake his “reform” as in Poland and Hungary. Benefits from what’s left of “traditional” Social Security will dwindle. Private-account fees will morph into a species of corporate welfare for Wall Street fund managers. And workers will find that private providers are unwilling to provide the annuity features that would be needed to take the place of the traditional system.

Fultz has done a terrific service providing an authoritative, detailed look at what went wrong in Hungary and Poland. A great deal of bandwidth is being wasted in Washington and in the mainstream media today on specious comparisons between the alleged federal debt crisis in the U.S. and the meltdown of the Greek economy. Fultz’s paper provides a cautionary tale that really could be our future under a Romney-Ryan administration.

2 Comments

Thanks for an informative overview of this intricate subject. One need only look as far as our own most recent economic meltdown to realize that privitizarion of SS is a very dangerous idea indeed. Do people really want to have their hard-earned security, for many their only financial safety-net, put at risk through “management” by the unfettered and irresponsible rogues of Wall St? I see a path littered with disaster…